ETFs
Nvidia Eclipsing Apple Threatens Radical $67 Billion ETF Shakeup
(Bloomberg) — One of the world’s largest technology ETFs appears poised for a shake-up after Nvidia Corp. has catapulted past Apple Inc. in size.
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Thanks to diversification rules, the $67 billion Technology Select Sector SPDR fund (ticker XLK) has held significantly fewer Nvidia shares for months now, while the AI giant continues to soar. Currently, the chipmaker represents about 6% of the fund’s assets, compared to 21% for the S&P 500 Information Technology Index, leading XLK to significantly underperform this year.
Now that Nvidia has surpassed Apple in value, its stake in XLK could see a drastic increase when the ETF conducts a quarterly rebalancing towards the end of this month, according to Bloomberg Intelligence.
The ETF will reflect the semiconductor pioneer’s entire capitalization – if Nvidia maintains its advantage over Apple on Friday, the day when the preliminary representation of each XLK member will be determined. In the process, Apple’s weight, currently at 21% of the fund, could fall to 4.5%, again thanks to this diversification rule.
Such a shakeup could prompt XLK manager State Street Global Advisors to invest $10 billion in Nvidia shares, according to Bloomberg calculations. At the same time, the fund is expected to shed about $11 billion in Apple stock. This is not a small transaction, especially for Apple. Over the past three months, the stock has changed hands at a rate of $11 billion per day.
“If Nvidia is bigger by the reference date, they will have to reverse the weightings and sell Apple,” said James Seyffart, an analyst at Bloomberg Intelligence. “They will do whatever is required by the rules,” he added. “In the past, they were forced to make even greater relative sales of a stock. »
A State Street spokesperson said the company would follow any revisions set by the index methodology. A spokesperson for S&P Dow Jones Indices declined to comment on potential changes to the index and referred Bloomberg News to the methodology.
It’s the latest example of how the relentless rally of tech giants is running up against the limits of regulations more than 80 years old. Established to protect investors following the stock market crash and the Great Depression, diversification rules can be detrimental in an unbalanced market.
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The problem is the capping of the impact of a title allowed in XLK. Although the fund is designed to mimic the returns of the traditional S&P 500 technology subindex over the long term, it tracks a version of the sector gauge maintained by S&P and follows the practice of limiting member weightings to avoid violating the diversification rules.
Similar restrictions prompted the Nasdaq 100 supervisor last year to conduct a special rebalancing to keep index funds in compliance with the rules. Under these rules, the combined representation of the largest companies – those that represent approximately 5% or more of a diversified fund – cannot exceed 50%.
When this rule is not followed, indexes such as the Nasdaq 100 tend to undercut major stocks proportionately. XLK’s methodology works differently. When a certain number of titles do not comply, the smallest of them is truncated.
In the previous two quarterly rebalances, Nvidia’s weighting in XLK was reduced to 4.5% each time because its value lagged behind Microsoft Corp. and Apple, and was therefore more exposed to a reduction. This happened even as the chipmaker accounted for 17% of the regular S&P 500 technology index in March and 11% in December.
As a result, XLK has suffered from not owning enough of Nvidia, with the latter surging about 145% year-to-date amid the AI frenzy. The ETF is lagging the traditional S&P 500 technology indicator by 4.5 percentage points this quarter – on track to achieve the widest dispersion since 2001.
In the event a change occurs, Chris Harvey, head of equity strategy at Wells Fargo Securities, is focusing more on the implications for how XLK might fit into an investor’s portfolio.
“The potential change between Nvidia increasing the size and Apple decreasing the size would make a very significant characteristic change to XLK,” he said. “We will have a more semi-oriented and dynamic ETF. This changes the characteristic, meaning it can change the way the ETF trades.
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